Dividends Assignment | Professional Writing

Carole B Inc. and Doc A Inc. are both operating in the amusement and animal park industry. Both companies have identical projects that will generate free cash flows of either $1 million per year going forward if the economy is doing poorly, or $2 million per year if the economy is doing well, with equal probability. Carole B Inc. has no debt, and Doc A Inc. has $10 million in perpetual debt outstanding, on which it is paying 6% interest per year. Suppose that there are no taxes, and after paying any interest on debt, both companies use all remaining free cash flows to pay dividends each year.

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Assume everyone has access to perfect capital markets. a) What are the payments that debt and equity holders of Carole B Inc. and Doc A Inc. will receive per year in each state of the economy? b) Suppose you own 25% of the outstanding equity of Carole B Inc. (and nothing else) but you just found out some information about Carole B Inc. and you do not want to invest in the company any longer. Instead you would like to invest in Doc A Inc. Construct a portfolio that would provide you with the same cash flows as your current investment. Note: Show your work in detail.

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